Expensive to be ignorant

2 March 2015

​Analysis: Lack of financial literacy makes it more difficult to make both ends meet. Instead, people use their overdraft facility, obtain easy accessible consumer loans or similar.

A new study shows that it is difficult for people with poor financial literacy skills to make the right decisions concerning personal finances.

“The results show that if you lack knowledge about personal finance, you make bad economic decisions which in turn reduce your living conditions,” says Louise Mogensen, Deputy Chief Executive at the Danish Bankers Association.

“Therefore,” Louise Mogensen further adds, “it is important that we enhance the Danes’ level of knowledge of personal finance. It is particularly important that we ensure that children and young people achieve the right skills to get a good financial start in life.”

Insufficient money

To uncover the relationship between financial knowledge and financial behaviour, the respondents in the Danish Bankers Association’s survey have been asked how often they have experienced that their income have not been able to cover their living expenses in the past year.

To this question, 15 per cent answer that they very often or often find it difficult to make both ends meet. Especially people with poor financial literacy find it challenging.

Almost 40 per cent of the people who state that they very often of often find it difficult to make both ends meet have poor financial literacy; while this only applies for 30 per cent of the group who have not experienced that the income was insufficient.

Figure 1. Financial literacy and experience of insufficient income

Source: A&B Analyse for the Danish Bankers Association.

Note: The above is based on a survey of 3,704 respondents. High level of financial literacy follows OECD’s definition and is characterised by 6 or more correct responses out of 8, while 5 or less categorises the person as having a low level of financial literacy. The differences are significant measured at a significance level at 95 per cent.

Consumer loans

The study also shows that people with lower financial literacy are more likely to make use of consumer loans (easy accessible loans) or similar.

“It is particularly problematic that people with poor financial skills make use of fast and expensive credit, as this behaviour typically is associated with high interest rates and fees, and thus makes it even more expensive for the individual. It can also make the individual more vulnerable to even small fluctuations in income, interest rates and payment requirements,” Louise Mogensen explains.

In the survey, every tenth person states that he/she within the past year often or very often has made use of credit options, such as consumer loans or similar, and almost 40 per cent of this group have poor financial literacy.

For the group who rarely or never make use of these credit options, the share with poor financial literacy is approx. 30 per cent.